(CN) - Lloyd's of London and Arch Specialty Insurance must pay the defense costs of alleged Ponzi scammer Allen Stanford and two former executives -- at least for now, the 5th Circuit ruled.
Last February, the SEC accused Stanford, 59, of operating a $7 billion Ponzi scheme through the sale of sham certificates of deposit. The government filed a parallel criminal case against Stanford, his former chief investment officer Laura Pendergest-Holt, and former accounting executives Gilberto Lopez and Mark Kuhrt.
The 21-count indictment charged them with conspiracy to commit mail, wire and securities fraud; wire fraud; mail fraud; conspiracy to obstruct an SEC investigation; obstruction of an SEC investigation; and conspiracy to commit money laundering.
All but Stanford's former CFO, James Davis, pleaded not guilty.
The Stanford companies were insured up to $100 million, and the policy required the underwriters to pay defense costs until there's a "final adjudication" that the insured committed fraud. In other words, the fraud exclusion doesn't apply until defendants are found guilty.
But the money laundering exclusion is different; it bars coverage for loss, including defense costs, from any claim stemming from alleged money laundering.
Lloyd's and Arch cited this exclusion when they notified Stanford that they would no longer provide coverage under the policy. They argued that the policy's definition of money laundering was much broader than the actual crime.
The executives sued in federal court in Houston, seeking reimbursement for their defense costs and a declaration that the underwriters had to pay such costs until a final judgment.
U.S. District Judge David Hittner agreed and barred the underwriters from withholding payment "until a trial on the merits in this case or such other time as this court orders."
The federal appeals court in New Orleans affirmed, but sent the case back for further consideration of the coverage question. Until then, Lloyd's must pay the executives' defense costs, the court ruled.
"The underwriters are enjoined from refusing to advance defense costs as provided for in the ... policy unless and until a court 'determines in fact' by clear and convincing evidence" that money laundering occurred, Judge Patrick Higginbotham wrote.
Stanford is in a Houston jail awaiting his January 2011 trial.
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